Section 179 Expense Election

Generally, the cost of property placed in service in a trade or business can't be deducted in the year it's placed in service if the property will be useful beyond the year. Instead, the cost is “capitalized” and depreciation deductions are allowed for most property (other than land), but are spread out over a period of years. Capitalization delays the tax benefits of business expenditures. For example, you may spend $50,000 on a new computer system today, but must spread your depreciation deductions over several years. That's why the election to take immediate deductions is valuable.

The expense election is made available, on a tax year by tax year basis, under Section 179 of the Internal Revenue Code (the “Code”), and is often referred to as the “Section 179 election” or the “Code Section 179 election.”

Subject to a dollar limit, the election allows you to deduct, in the tax year for which the election is made, the cost of qualifying property (described below) placed in service during the tax year. The immediate deductions allowed are in lieu of capitalization and later depreciation deductions. The deduction limit is $500,000 for a tax year beginning in 2011 ($139,000 for a tax year beginning in 2012). As discussed below, the deduction is phased out (i.e., gradually reduced) if (1) more than $2,000,000 of qualifying property is placed in service during a tax year beginning in 2011 or (2) more than $560,000 of qualifying property is placed in service during a tax year beginning in 2012.

Qualifying property. To qualify for the election, the property must be “tangible personal” property. This means that real estate (buildings and their structural components) does not qualify, nor do intangibles such as patent rights. However, the following types of property also qualify: (1) for a tax year beginning in 2011, up to $250,000 of real property consisting of certain leasehold improvements, retail improvements or restaurant property, and (2) for tax years beginning before 2013, off-the-shelf computer software. Also, to qualify, property must be “purchased.” Thus, if, for example, you acquired the property in a tax-free exchange, by gift or inheritance, or from an individual or entity to which you bear a close relationship specified in the Code, the property does not qualify.

Dollar limit. The dollar limit doesn't mean the election can't be made for property costing more than that amount. For example, if you buy a machine for $600,000 and place it in service in a business in a tax year beginning in 2011, you can elect to immediately deduct $500,000 of its cost for that year. The remainder of the cost ($100,000) qualifies for 100% bonus depreciation. Also, you can make the election for two or more separate assets, as long as the total cost covered by the election doesn't exceed the dollar limit for that year.

As mentioned above, if the total cost of qualifying property that you place in service during a tax year beginning in 2011 is over $2,000,000 (over $560,000 for a tax year beginning in 2012) (i.e., the “phaseout” amount), the immediate deduction limit is reduced by that extra amount. For example, if you place in service $2,200,000 of qualifying property in a tax year beginning in 2011, you can make the election for no more than $300,000 of property ($500,000 minus $200,000 [excess of $2,200,000 over $2,000,000]).

Taxable income limit. If your taxable income from all of your trades or businesses is less than the dollar limit for that year, the amount for which you can make the election is limited to that taxable income. However, for most types of property, any amount you can't immediately deduct because of the taxable income limitation is carried forward and can be deducted in later years (to the extent that the applicable dollar limit, the phaseout rule, and the taxable income limit permit).

Recapture. If you dispose of the property, or stop using it in a trade or business, before the end of the cost recovery period that would have applied to the property had you not made the election for the property, all or part of the amount of the deduction you claimed under the election must be taken back into income (“recaptured”). Exactly how much will depend on the type of property and how long you used the property in a trade or business.

The above information covers the essential elements of the Code Section 179 election. Clearly, many considerations go into each decision to acquire business assets, and many involve non-tax factors. However, the election should play a role; accelerated tax benefits may enable you to obtain the property you need earlier and at reduced after-tax costs.